By Wayne Cole
TOKYO, June 26 - The dollar suffered a rare bout of nerves Tuesday, shying lower as an impending Federal Reserve meeting generated even more than its usual charge of uncertainty.
Dealers are unsure how far the Fed will cut rates or what it will say about the outlook for the economy and for policy. There are even whispers it might express its frustration with the way the strong dollar has been impeding exports, though most felt the bank would avoid such a contentious subject.
And, for once, the outlook for euro zone policy looked a little clearer with a pullback in German consumer prices pointing to a possible peak in inflation which could allow the European Central Bank to ease before the summer recess.
All of which encouraged a generally long market to take profits on the dollar's recent strength and helped the euro firm to $0.8617 from $0.8586 in New York and a low of $0.8492 last week.
Traders reported sizeable offers around $0.8630 but saw scope to test major resistance at $0.8670 given the result of the two-day Fed meeting would not be known until Wednesday.
The euro was holding firm on the yen at 106.48 having briefly touched one-month highs at 106.96 offshore.
The dollar in turn slipped away to 123.58 yen having already dropped to 123.80 in New York from Friday's two-month peak around 124.74.
A TALE OF TWO MEETINGS
The yen has a central bank policy meeting of its own to fret about this week. While few analysts expect the Bank of Japan to ease on this occasion the pressure is building for more drastic action, perhaps including measures such as buying foreign bonds which would serve to indirectly weaken the yen. The Fed's gathering is much more uncertain with the market divided almost evenly on wether it would cut by 25 or 50 basis points. According to the latest poll, 14 of 25 primary bond dealers are forecasting a quarter but the number looking for a half has expanded to 11.
Up to now the Fed's blitzkreig campaign of five half-point cuts, while eradicating the dollar's interest rate advantage., has done the currency scant harm since investors were more focused on the promise of a speedy economic rebound.
But with the first half of the year almost over and little sign of a recovery, particularly in manufacturing, nerves are becoming strained.
"There is so much uncertainty over the economy right now that if the Fed goes by 50 (basis points) there is a risk that the herd thinks the bank knows something they don't and it ends up hurting the dollar," said Clifford Bennett, currency strategist at BNP Paribas.
SIZE NOT EVERYTHING
Market misgivings extend to the outlook for policy as well.
"We have been calling for 50 basis points for some time now," said James Malcolm, an economist at J.P. Morgan. "But I think the statement released at the same time will be more important than the size of the cut itself."
He expected the Fed to emphasise that poor growth was more of a risk than inflation, so keeping an implicit easing bias.
Indeed, some were hoping the bank would go a step further and leave the door open for an inter-meeting move by re-introducing a past line about the need to monitor developments closely.
That would give shaky financial markets something to cling to in the two-month gap until the next FOMC meeting on August 21.
Nevertheless, having already chopped the funds rate to 4.00 percent some worry the Fed is running out of room for such "comfort" cuts.
In particular the 3.00 percent level was looming large as a potential barrier for the funds rate. This was the absolute trough of the 1989-1992 easing cycle and before that you have to go back to the halcyon days of the 1950's and early 60's to find lower rates.